Wash Sale Losses

Many tax preparers and taxpayers struggle with wash sale loss rules

Congress doesn’t want taxpayers to realize “tax losses” that are not “economic losses.” If you close a securities transaction and re-open it right away, you haven’t closed your financial position in that security. At year-end, many taxpayers do “tax loss selling” of securities in December, and the IRS wash sale rules defer the loss if the taxpayer re-purchases a substantially identical position within 30 days before or after, which means into January of the subsequent year. 30 days is an eternity for day and swing traders.

Section 1091 Wash Sale Rules Per IRS Publication 550:

  • A wash sale occurs when you (a taxpayer) sell or trade stock or securities at a loss and within 30 days before or after the sale you:
  • Buy substantially identical stock or securities,
  • Acquire substantially identical stock or securities in a fully taxable trade,
  • Acquire a contract or option to buy substantially identical stock or securities, or
  • Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

Wash-Sale Rules Differ Between Brokers And Taxpayers

IRS regulations for Section 1091 require taxpayers to calculate wash sales based on “substantially identical” positions. That’s different from the rule for brokers that require “identical” positions. This can be a problem or challenge for active traders who trade stocks and options, or just options but with constant changes in exercise dates. Starting in 2014, 1099-Bs included equity options for the first time.

Many brokers report “disallowed wash sales for the year” on 1099-Bs rather than “actual wash sales” at year-end. This causes confusion and anxiety for many taxpayers, who draw the wrong conclusion and may think they have a huge problem at year-end, when they may not. The “disallowed wash sales for the year” number may count the same wash sale over and over throughout the year. What counts more is what wash sales are deferred at year-end, and what ones were permanently lost to IRA accounts.

Many traders and local tax preparers who are not that savvy to the wash sale rules may leap to import 1099-Bs into TurboTax, but they will probably not comply with Section 1091. In effect, they are using broker rules and unknowingly or willfully disregarding Section 1091. (Read Form 8949 & 1099-B Issues.)

Strategies To Avoid Wash Sale Losses

Consider a “Do Not Trade List” to avoid permanent wash sale losses between taxable and IRA accounts. For example, trade tech stocks in your individual taxable accounts and energy stocks in your IRA accounts. Otherwise, you can never report a wash sale loss with an IRA, as there is no way to record the loss in the IRA.

Break the chain on wash sale losses at year-end in taxable accounts to avoid wash sale loss deferral to 2019. If you sell Apple equity on Dec. 20, 2018, at a loss, don’t repurchase Apple equity or Apple equity options until Jan. 21, 2019, avoiding the 30-day window for triggering a wash sale loss. Wash sale loss adjustments during the year in taxable accounts can be realized if you sell/buy those open positions before year-end and don’t buy/sell them back in 30 days.

Consider A Section 475 Election

Business traders qualifying for TTS are entitled to elect Section 475 mark-to-market (MTM) accounting elected on a timely basis, which exempts them from wash sale loss adjustments and the capital loss limitation.

For more in-depth information on wash sale tax treatment, see Green’s 2018 Trader Tax Guide.